How well do REITs do in a recession?
The FTSE Nareit All Equity index, consisting of REITs that exclude mortgages, generated a 15.9% annualized return during recessions and 22.7% in the year following the end of a downturn, according to the National Association of Real Estate Investment Trusts.
Rising interest rates hurt not only the value of REITs' property holdings but also the cost of debt to finance those properties or even refinance already-owned assets.
Even with inventory levels driving up prices, investing in real estate during a recession could still result in significant long-term returns.
The strong finish kept domestic REITs in line with the broader markets in 2008. The S&P 500 dropped 37 percent for the year, while the NASDAQ Composite fell 40.54 percent. The Russell 2000 was down 33.79 percent, and the Dow Jones Industrial finished 2008 down 33.84 percent.
Right now, REITs (VNQ) are at an inflection point and time is running out for investors. But now as we head into 2024, we expect the polar opposite and this should lead to an epic recovery across the REIT sector. The Fed expects at least 3 interest rate cuts in 2024 and the market is predicting even more.
But despite that, most REITs have kept growing their dividend. Most of them hiked in 2022, 2023, and will hike again in 2024. This is the ultimate proof that REITs are doing better than what the market appears to believe.
But since REITs are invested in property, there's more protection against the horror show of having shares crash to $0. By law, 75% of a REITs asset must be invested in real estate. The market value of the property owned by the REIT offers a bit of protection, as long as the value of the property doesn't go to zero.
Commercial Properties
As with residential rentals, the ideal properties are those that need few upgrades and already have long-term tenants. For short-term investments, location is also important. Recessions generally have less effect on high-income neighborhoods, so focus your efforts there.
Historically, multifamily properties have been a source of stability for real estate investors. They provide a steady source of income through rent, and there is always a demand for occupancy. The risks associated with owning a multifamily property are much lower during a recession than a single-occupancy home.
Cash: Offers liquidity, allowing you to cover expenses or seize investment opportunities. Property: Can provide rental income and potential long-term appreciation, but selling might be difficult during an economic downturn.
What is the 90% rule for REITs?
How to Qualify as a REIT? To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.
As interest rates rise, they can depress the price of these REITs. So while dividends may climb with interest rates, the price of publicly-traded REITs may decline. Historically, REITs are one of the better-performing sectors during inflationary periods.
U.S. REITs Performance in Inflationary Environments
During historical periods of medium-to-high inflation and rising interest rates, REITs have generated positive total returns and outperformed equities, as compared to the S&P 500 and the MSCI AC World Index.
Non-traded REITs have little liquidity, meaning it's difficult for investors to sell them. Publicly traded REITs have the risk of losing value as interest rates rise, which typically sends investment capital into bonds.
The REIT sector had a rough start to 2024 with a -5.72% total return in January. Large cap REITs (-4.79%) outperformed their smaller peers in January. Micro cap REITs (-8.39%) averaged the steepest declines. Only 9.55% of REIT securities had a positive total return in January.
As we dive into 2024, the Fed's accommodative approach to tackling inflation is likely to provide an impetus to the REIT sector, which depends highly on the debt market to carry out business activities. These companies benefit from lower borrowing costs. Moreover, low interest rates contribute to higher valuations.
In fact, REIT total returns bounced back with impressive performance in the last quarter of 2023. Based on historical experience, the convergence of the wide valuation gap between public and private real estate will likely ensure continued REIT outperformance into 2024.
REITs historically rebound when interest rates pivot and have the potential for rent growth. Realty Income, Agree Realty, VICI Properties, Essential Properties Trust, and American Tower are strong picks for long-term growth and income.
There are three key reasons to invest in listed REITs right now, starting with the fact that REITs have outperformed stocks and bonds when yields and growth move lower. Demand is health while supply is constrained, and REIT valuations relative to the broader equity market are meaningfully below the historical median.
A lot of REIT investors focus too way much on the dividend yield. They think that a high dividend yield implies that a REIT is cheap and a good investment opportunity. In reality, it is often the opposite, and the dividend does not say much, if anything, about the valuation of a REIT.
How long should I hold a REIT?
"Both public and non-public REIT investments should be considered long-term, and that could mean different things to different folks, but in general, investors who typically invest in REITs look to hold them for a minimum of three years, and some of them could hold them for 10+ years," Jhangiani explained.
REITs don't have to pay a corporate tax, but the downside is that REIT dividends are typically taxed at a higher rate than other investments. Oftentimes, dividends are taxed at the same rate as long-term capital gains, which for many people, is generally lower than the rate at which their regular income is taxed.
Because a decline in disposable income affects prices, the prices of essentials, such as food and utilities, often stay the same. In contrast, things considered to be wants instead of needs, such as travel and entertainment, may be more likely to get cheaper.
Treasury Bonds
Investors often gravitate toward Treasurys as a safe haven during recessions, as these are considered risk-free instruments. That's because they are backed by the U.S. government, which is deemed able to ensure that the principal and interest are repaid.
Options to consider include federal bond funds, municipal bond funds, taxable corporate funds, money market funds, dividend funds, utilities mutual funds, large-cap funds, and hedge funds.
